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Hands buys LP interests

As the spectre of LP defaults looms larger, Guy Hands'Terra Firma has attempted to get ahead of the issue by buying out LPs from its 2007 fund.

A combination of factors – including slowing cash distributions and the denominator effect – has forced many LPs to reduce their exposure to private equity, either through selling fund interests on the secondaries market or negotiating with GPs to scale back their commitments. In response, several private equity firms have taken measures to allow illiquid LPs to scale back commitments to their funds.

Terra Firma, the UK buyout house run by Guy Hands, has made the unusual move of buying three limited partners out of its 2007 fund at “a small premium” to the face value.

In another move aimed at solving a similar problem, London-based Candover revealed it would have to shrink its 2008 fund, for which it had raised almost €3 billion of its targeted €5 billion, while SVG Capital, the listed fund of funds which invests predominantly in Permira's funds, has also confirmed it will shrink its investment in the €11.1 billion Permira IV fund to 60 percent of its original €2.8 billion commitment.

The move came after Permira, whose funds constitute 82 percent of SVG's portfolio, extended a lifeline to those limited partners in its fourth fund who were at risk of defaulting on capital calls by allowing them to reduce commitments. The offer was taken up by 10 percent of Permira IV's 180 limited partners, meaning the fund will be no smaller than €9.6 billion, a reduction of 13 percent from its original size of €11.1 billion.

Hands, who was already one of the four largest investors in the Terra Firma fund, has been in discussion with each of his 170 LPs to ask if they have the liquidity to meet future capital calls. The three fund interests, which between them are liable for €25 million in uncalled commitments, were bought by the fund's management company, while the sellers comprised two large institutions and one family-owned group.

The firm also made the unprecedented decision to return carried interest accrued since 2004 to limited partners, a sum amounting to around €80 million. “Our investors have suffered and therefore our rewards should suffer at the same time,” Hands said in a statement. “Such longer-term rewards throughout the entire financial system would have led to a very different world to the one we find ourselves in today.”

Terra Firma's move to buy out its LPs is intended to help avoid the problem of defaulting LPs or the need to preemptively shrink the fund's size, which leads to lower fee revenue and potentially forces a change of fund strategy. If successful, it may be a strategy that other firms emulate when dealing with similar problems in the future.

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